Philosophically, reducing your financial competency to a credit score number is problematic.
Should your bad credit behavior at 18 haunt you for the rest of your life?
Can we just move on from that one time you forgot you got concert tickets on a credit card they offered you and used an old address so by the time you found out about it, it was in collections?
Yet, this is the world we live in, where credit scores matter.
There’s hope! Time and improved behavior does heal all wounds when it comes to your credit. For example, after 10 years a bankruptcy will be off your report and it’s often much less time to have delinquent accounts removed.
Just a quick note, this article is specifically on understanding credit scores. To read more about managing debt check out Debt – A Labyrinth.
Okay, so what’s a credit score?
A credit score is used to measure your ability to pay back debt by reviewing your past behavior. A good credit score gives you several benefits, among them:
- Getting an apartment! Many landlords will run a credit check before renting out an apartment.
- Lower interest rates on loans, from credit cards to a mortgage. This can be huge!
- Getting a job! Some employers will run a credit check.
A credit score is made up of five different elements as shown in the image below:
Image thanks to Southern Wesleyan University
New credit – Whenever you open a new credit card or loan this lowers your credit score.
Types of credit used – Not all credit is created equal. Mortgages are looked at more favorably because there’s a house that can be repossessed if you are late on payments. Credit card debt is the least positive because it’s unsecured debt, there’s nothing the credit card company can repossess.
Length of credit history – The longer you’ve had a credit history the easier it is to project how you’ll use credit in the future.
Amounts owed – The less of the credit you use, the better for your score. The general recommendation is to only use a third of available credit. So if your limit is $3,000 on a credit card, try to use $1,000 or less on it.
Payment history – By far the most important! Make payments monthly and on time, at the very least the minimum payment to improve your credit score.
How do you build credit?
First, you get started. Open a credit card and make at least monthly payments on it. Even better, pay it off every month so that you do not pay interest on the money borrowed.
The earlier you get started the longer your credit history. Unfortunately, the younger we are the more likely that we’ll have a hard time using this financial product well. It’s easy to spend on a credit card and get confused about how much is left to pay it off.
There are credit building products like a secured credit card. With a secured credit card you’re only allowed to spend money that you’ve already paid into it. Over time this will establish a payment history so that you can open an unsecured credit card.
If you’re working on repairing your credit, you can close accounts you don’t need, but make sure to keep the oldest ones open to have a long credit history. Also, make sure your credit report is accurate.
What if you find an error in your credit report?
It’s important to review your credit score at least annually. There are three different credit reporting bureaus, so you could review your credit every four months by reviewing one agency at a time. The three agencies are Experian, Transunion, and Equifax. Go to https://www.annualcreditreport.com/index.action for your free report.
We often hear people brag on their credit score number, but accuracy of the report is more important than the score itself! Many credit score agencies give an estimate, which is different than the actual score a lender has access to.
If you find an error on your report you need to open a dispute with the company who reported the error. Common examples of errors are:
- There’s a credit under a name that isn’t yours
- You don’t recognize an account
- Amount owed is incorrect
- An address is incorrect
Keep an eye for anything related to identity theft, like a new credit card or address you don’t recognize. In the case of identity theft, freeze your credit with all three agencies to prevent new loans. Identity theft is a big deal and reviewing your credit report can help you stay ahead of it!
Racism, Sexism and Credit
In the US we have a segregated credit market. In The Color of Money Mehrsa Baradan points out that in low income communities borrowing is simply more expensive.
Although the Consumer Financial Protection Bureau outlines that credit discrimination is illegal, there is a strong correlation between credit availability and zip codes. The wealthier, whiter, and/or more family oriented the zip code, the better the credit card offers.
The Equal Credit Opportunity Act was passed in 1974, yet its mandate to provide everyone with equal access to credit is still not fully in practice. Before 1974 a woman could only apply for a loan or credit card if a man (her husband or father) vouched for her.
Incredibly, women received access to credit 54 years AFTER the right to vote.
What’s in a number?
My parents gifted me with a great credit score. When I was in college my mom put me down as a co-signer on her car loan. She made the monthly payments on time, and this went on my credit report to show credit history and good payments on my behalf. I never even drove the car, but benefited from my mom’s savvy.
I’m not sure how my mom found out about that, but I’m glad she did! She and my dad are the first ones in our families to immigrate to the US and taught my brother and I that having a good credit score is important.
Funny enough, after decades of struggling financially my parents have each changed their tune. My mom had to go through bankruptcy because her small business kept hitting roadblocks, from having merchandise stolen to the place being burned to the ground.
Separately, during a difficult time my dad realized that he could make do without credit and opted to reinvest in his business instead. So yeah, he’s late on payments, but in his words, “A mi que? No ocupo que me presten.” (So what? I don’t need them to lend me money.)
My dad also doesn’t need to rent because he owns his home, and he’s not worried about getting a job since he’s been self-employed the majority of his life. His reasoning resonates with what Dave Ramsey says about credits cores. But unless you’re where my dad is with money or are a die-hard Dave Ramsey follower, take care of your credit score.
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